Misuse of the FHA Preforeclosure Sale Program may have cost the Department of Housing and Urban Development (HUD) over a billion dollars for claims that did not meet program according to an audit released this week by the HUD's Region 7 Office of Inspector General (OIG).  OIG initiated the audit after noticing significant deficiencies in borrower qualifications during an audit of program claims at one large lender.

The Preforeclosure Sale Program allows borrowers in default due to an adverse an unavoidable financial situation to sell their home at fair market value and use the proceeds to pay off an FHA-guaranteed mortgage loan even if the debt exceeds the proceeds of the sale, i.e. a short sale.  Lenders must maintain supporting documentation to demonstrate that the borrowers would financially eligible for the program and both lender and borrower are paid a cash incentive of up to $1,000 for participating in the program.

FHA paid claims on nearly 20,000 short sales from September 1, 2010 to August 31, 2011 with claims totaling more than $1.7 billion.  The volume of these sale claims has been increasing relative to foreclosure claims in the past five years.

During the audit OIG reviewed a statistical sample of 80 claims from among 16,976 submitted by the nine largest lenders based on their preforeclosure sale volume.  Of the 80 files reviewed, OIG found that 61 or 76.3 percent were ineligible because they did not meet the participation criteria on the basis of their finances as demonstrated in the following table.  Fifty-five of those claims came from lenders involved in the $25 billion servicer settlement.

 (The number of claims in the table exceeds the cases reviewed because of multiple deficiencies.)

By projecting these ineligible claims to the universe of 16,976 claims OIG estimated that at least 11,693 of those claims were ineligible and projected the cost to HUD at $1.06 billion.

OIG found the HUD had inadequate controls in place to enforce the program requirements and those requirements were not well written.  For example, HUD had certain built-in edit checks to ensure that it paid accurate amounts, but these checks addressed computations and relationships among fields rather than whether the borrower was qualified.  The qualification issue was likewise not addressed during a post-claim review.  Another example:  the mortgagee letter cites the participation criteria but not enough detail to ensure consistent application of the criteria.  One lender said he thought assets mattered only if they were sufficient t pay off the mortgage.

The $1 billion plus in ineligible claims does not represent a direct cost to the FHA insurance fund.  The ultimate loss to that fund, OIG said, would likely be less than this amount because it is reasonable to assume that at least some of these loans would have gone to foreclosure and become conveyance claims.  However, it is also reasonable to assume that some would have resulted in no claim or reduced claims due to alternative mitigation procedures.

Over the most recent five year period the loss per short sale has increased as the volume of those sales has also dramatically risen.  HUD expects this to continue and as a result OIG says HUD will continue to pay improper claims if it does not improve its controls over the program.

OIG makes three recommendations for action by the Deputy Assistant Secretary for Single Family Housing:

1.      Require lenders to reimburse the FHA insurance fund for six of the improper claims totaling $360,760.

2.      Strengthen controls of the preforeclosure sale program, including the mortgagee letter and program oversight, to put more than $781 million (the amount OIG estimates could be saved through its recommendations) to better use.

3.      Educate lenders on the appropriate and proper use of the program.